Bank loan

When should you take out a bank loan to buy a car?

As a youngster who moved to Delhi from a small town, Vaasu always wanted to drive his own car. It has now been five years since he started working in Delhi. Promotional campaigns for cars always catch his eye and he thinks he should buy one soon. He receives Rs 50,000 as net salary after all deductions and taxes. His bank is willing to grant him a loan of Rs 7 lakh, repayable over five years in a monthly installment of Rs 15,500. What will be the implications of this decision on his finances?

Vaasu’s loan will be around 30% of his net salary, leaving little room for other loans. If he has to take out a personal loan, a student loan or a mortgage, his big car loan will be a brake. If he’s sure he doesn’t intend to take out any more large loans in the immediate future, he could go ahead with the car loan.

The fixed nature of the monthly installment will mean that as Vaasu’s take-home pay increases, the car loan will become a smaller percentage of his income and leave room for more loans, if needed. Vaasu needs to consciously build that headspace by not taking too many loans in the meantime. If compulsory expenses (rent, groceries, bills, etc.) occupy about 60% of his income, after the car loan, he only has 12% of his income in the form of savings. Disciplined investment of savings is necessary to balance one’s assets. A car is a depreciating asset, the resale value of which will be much lower than its cost. If he invests part of his savings in asset appreciation, even while he is servicing his loan, he would have created a reserve. If necessary, it can borrow from other assets it holds.

It is not always necessary to hold back and save every rupee. Vaasu should treat himself and feel happy that he bought his car. He just needs to be sure that he gives himself space and time to earn and save for a while, before needing another loan from his bank.

Content on this page is courtesy of the Center for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta